Perpetual Investments has reduced by two-thirds the allocation to nominal bonds in its balanced fund, downweighting the UBS Composite exposure in favour of floating-rate credits and inflation-linked bonds, as it seeks to lower the duration and bolster the returns of its portfolio.
Perpetual’s portfolio manager for diversified funds, Michael Blayney, said the decision to reduce weighting to nominal bonds from 15 per cent to 5 per cent was a strategic one, because the manager believed the average duration of the UBS Composite Bond benchmark had become too high.
In an environment where a secular move to higher inflation was was a key risk, Blayney said the inflation risk inherent in traditional longer-dated sovereign and semi-government bonds had become too great, and the yield compression which had already occurred – squeezing the average nominal bond yield to just over 5 per cent – meant the potential for future upside was limited. Floating rate credit and inflation linked bonds were seen as a natural defensive investment given the fund’s “CPI plus” return objective.
It is a view that informed the launch late last year of Perpetual’s Dynamic Fixed Income Fund, which Blayney said is free to “swing” between credit risk and duration risk, and reflects the managers’ view that a fixed income portfolio’s average duration should be determined based on “analysis of volatility, diversification relative to growth assets, and an appropriate balance of credit and duration risk”.
The duration for a traditional index, however, is a function of whatever bonds happen to be on issue at the time, which Blayney believes leads to “illogical consequences” – such as duration lengthening when yields are low, simply as a result of more government issuance. The duration target of the fund has been set to two years, compared to the current duration of the UBS Composite of 3.5 years.
The Fund is able to go to a maximum average duration of four years, and a minimum of zero.